Markets are riding high on a wave of vaccine-induced enthusiasm. What better time, then, to step back and take a look at what may prove to be the pandemic’s most damaging legacy: a mountain of debt.

Government and household debt levels have both increased sharply since the pandemic began. But in Europe, corporate debt is a cause for particular concern. Companies forced to limit or cease activity during lockdowns have still had to finance their business and partly pay their staff. As a result, corporate borrowing has shot up, helped by state guarantees and central bank stimulus. In the first half of this year alone, euro-area companies issued €400bn of debt – 40% more than was added during the whole of 2019.

The consequences of a huge debt overhang could weigh on European corporates for along time, especially small and mid-sized companies. As debt servicing becomes more difficult, the appetite to invest in capacity and create new jobs will potentially be hampered. The risk of defaults can’t be ignored either. The German Bundesbank is already expecting insolvencies to rise by 35% in the first quarter of 2021. In the face of bonds yielding negative, what are the prospects? 

For investors, the answer may be to look East. A third of global GDP is being created in Asia, home to some of the world’s fastest-growing economies. In terms of portfolios, Asian debt remains under-represented, accounting for just 7%of the Barclays Global Aggregate Bond Index, a common benchmark for active funds. At the sovereign level, thanks to prudent fiscal policies, debt growth in Asia is better than in other emerging markets and the developed world. The risk-reward benefit is the highest, too, with Asia’s volatility much less than other emerging markets, notably Latin America.

As Europe digests its debt binge in the months to come, Asian debt will give investors plenty of food for thought.

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